1. Field of the Invention
This invention relates generally to an automated system for matching orders to buy and sell securities at the midpoint of a best bid and offer (“BBO”). More particularly, the present invention relates to an exchange for receiving orders to buy or sell securities where the best bid or offer prices (BBO) are displayed coupled with a hidden reserve book of orders that can be matched at the midpoint of the BBO and where orders on the displayed market are matched with orders on the hidden reserve book if the orders on the displayed market are marketable at the midpoint of the BBO.
2. Background Discussion
Conventional trading of securities, such as, for example, stocks, exchange traded funds (“ETFs”), and listed equity options, takes place on a national securities exchange that is registered as such with the United States Securities and Exchange Commission. Exchanges may be floor-based, fully-electronic, or utilize a hybrid model that incorporates some floor-based features and some electronic features. An example of a floor-based exchange is the New York Stock Exchange (“NYSE”). An example of a fully-electronic exchange is the International Securities Exchange (“ISE”). An example of a hybrid exchange is the Chicago Board Options Exchange (“CBOE”).
At a conventional exchange, the members of the exchange send their proprietary orders and their customers' orders to the exchange for execution. These exchanges also include market makers or specialists, who contribute proprietary quotes to the exchange. These exchanges are, for the most part, fully-transparent, wherein they each disseminate a BBO and they report the prices at which securities are quoted, bought, and sold to reporting entities that consolidate trading information and disseminate trading data, including a national best bid and offer (“NBBO”). Some exchanges also display the depth of their order books, meaning they display the available size for all prices in the security, above and below its BBO. One of the principal advantages of trading at such exchanges is that orders sent to such exchanges, if marketable (that is, for example, if it is an order to buy, then such buy order is priced at or higher than the best offer), are immediately executed up to the available size displayed in the exchange's BBO. Such markets are sometimes referred to as displayed markets.
For certain types of traders, namely buy-side traders (such as, for example, money managers, mutual funds, pension funds, etc.), the disadvantages of trading at such exchanges may outweigh the advantages. These disadvantages can include higher costs (e.g., payment of the spread—the difference between the best bid and the best offer—as well exchange transaction fees), a lack or compromise of anonymity, ill-equipped electronic execution systems (e.g. SuperDOT), and market impact—that is, the market movement that results when a large order is received. Additionally, too much transparency can also be a disadvantage, depending on the trader and the trade.
As a result, buy-side traders, who were less concerned with the principal benefit afforded by exchanges—immediacy of execution—have sought exchange alternatives that offer lower-cost execution, anonymity, and a reduction in, or elimination of, market impact upon receipt of large orders. This demand led to the development of alternative trading systems, including crossing networks (“Crossing Networks”), such as ITG's POSIT, Liquidnet, Harborside+, and Pipeline Trading. The SEC defines an “alternative trading system” as a system that provides a marketplace for bringing together purchasers and sellers of securities that does not set rules governing the conduct of its participants or discipline its participants.
Crossing Networks provide independent liquidity pools without dealers, and match (or facilitate the matching of) buy and sell orders at a reference price, usually derived from a BBO or other prices from a conventional exchange. Crossing Networks can be passive (meaning executions only occur at certain, pre-defined matching periods), or continuous (meaning executions may occur at any time during the trading day). The common denominator in all current and former Crossing Networks is that they are intentionally, specifically, and, in many cases, exclusively designed to execute block-sized orders—orders to buy or sell a significant number of shares. Following is a brief description of the current, principal Crossing Networks.
ITG's Posit, which is a service available to both buy-side and sell-side participants, operates a passive, midpoint “call market,” where a cross occurs roughly every half-hour throughout the trading day. At a random time selected within a one minute window of time after each cross begins, a midpoint price is set at which all matching buys and sells are executed.
Liquidnet, which is a service offered to buy-side institutions only, operates continuously throughout the day. Institutions make the trade blotters of their order management system (“OMS”) available to be compared on Liquidnet, which notifies each party when a potential match is found. If parties are interested at that point, they then go into electronic, anonymous negotiation to consummate a trade.
Harborside+, which is a service available to both buy-side and sell-side participants, operates continuously throughout the day. Similar to Liquidnet, it looks for potential matches on OMS blotters. When a match is found, a human broker at Harborside+ calls each party and seeks to help both of them negotiate to complete a trade.
Pipeline Trading, which is a service available to both buy-side and sell-side participants, relies on participant systems entering block orders into its system. Orders that are entered result in screen displays lighting up the symbols of the entered stocks, but does not disclose side. Orders may be priced at any price or at midpoint, which is encouraged by granting near-match notification to midpoint enterers that there is a potential counterparty at a price not far from the midpoint.
While each of the current, principal Crossing Networks has its own, unique limitations, all current, principal Crossing Networks also contain a common limitation in that they lack order processing and matching features necessary to process multiple, computer-generated orders, of any size, transmitted by algorithmic, program, and other automated trading systems and automatically match multiple, executable orders. These trading systems continue to gain in popularity, and are accounting for an increasing percentage of the total volume traded on the conventional exchanges. Further, the current, principal Crossing Networks either prohibit (via not permitting access to their systems) or discourage (via making trading uneconomic through charging higher buy-side-like fees) sell-side traders from participating. Sell-side traders and their customers, who they tend to grant direct, sponsored access to the exchanges, are the traditional users of algorithmic, program, and other automated trading systems. In addition, however, buy-side firms are increasingly starting to utilize algorithmic, program, and other automated trading systems. Moreover, principal Crossing Networks do not readily accommodate order shredding or volume weighted average pricing (“VWAP”) trading strategies that are the antithesis of block trading methods. In addition, inevitably, each of the current Crossing Networks has some form of information leakage or gaming ability, which results in compromises in anonymity, either built in by screen displays (Pipeline Trading), through the “sniffing of blotters,” or by word of mouth from human intermediaries (Harborside+ and Posit, which also operate agency desks). None of the current, principal Crossing Networks are adapted to receive, process, and match computer-generated orders, of any size, created by algorithmic, program trading, and other automated trading systems.
Thus, Crossing Networks do not provide an efficient trading solution to market participants that utilize algorithmic, program, and other automated trading systems, which market participants are accounting for a continually increasing percentage of overall traded volume on conventional exchanges. Thus, it would be an advancement in the state of the art to make available an automated system for matching orders to buy and sell securities at the midpoint of a BBO, wherein the automated system is adapted to (i) operate on a fully-anonymous and continuous basis, (ii) process multiple, computer-generated orders, of any size, transmitted by algorithmic, program, and other automated trading systems, (iii) automatically match multiple, executable orders according to a priority scheme, and (iv) execute a matching algorithm that maximizes tradable volume when an executable order can not be matched according to the priority scheme.
It would be an advancement in the state of the art to make available an automated system for matching an order to buy and/or sell a security at the midpoint of a BBO where the order is stored in a hidden reserve book until a contra order, executable against the order at the midpoint of the BBO is received. Buy-side investors, who typically place large block orders benefit from such a hidden reserve book because exposure of large block orders may disrupt the market, resulting in such orders receiving worse prices. By allowing block orders to trade at a midpoint of BBO price, large orders can trade with one another without disruption of the market.
It would also be an advancement in the state of the art to make available a displayed market linked to a hidden reserve book so that orders placed on the displayed market can trade against orders stored on the hidden reserve book. Current exchanges display a best bid and offer price for securities, and may provide other information concerning the liquidity of their market, for example, size at BBO and sizes at prices worse than the BBO. Marketable orders sent to current exchanges are executed at the BBO. In general, if an order is not marketable when it is submitted to a current exchange, the order resides on the book and awaits a counter order that will make the order marketable. Current markets lack the ability to inspect orders stored in hidden reserve books and thus, do not make the liquidity of the displayed market available to orders on the hidden reserve book. Such markets also do not provide price improvement between the BBO and the midpoint of the BBO to orders placed on the displayed market when orders available to trade at the midpoint of the BBO are stored on the hidden reserve book.
It would also be an advancement in the state of the art to provide a means whereby orders submitted to a displayed market receive a price improvement by providing an opportunity for such an order to trade on a midpoint matching system. The matching midpoint price is by definition better than the price that could be obtained in the displayed market.
On Apr. 6, 2005 the SEC voted to adopt Regulation NMS (“Reg NMS”), which contains proposals designed to modernize the regulatory structure of the U.S. equity markets including the Order Protection Rule. The Order Protection Rule requires exchanges to obtain the best price for investors when such price is represented by automated quotations that are immediately accessible. Specifically, the rule requires exchanges to establish, maintain, and enforce written policies and procedures that are reasonably designed to prevent trade-throughs.
The introduction of Reg NMS has caused trading to increase in frequency and trade size to decline. The limit order protection proposals have increased demand for non-transparent execution methods including systems with hidden reserve books. Traditional crossing networks suffer from a declining interest in block-based services, an increase in per ticket clearing costs, and a lack of ability to recoup those costs through tape prints. Thus, it would be an advancement in the state of the art to provide a system where liquidity of orders placed on a hidden reserve book is improved by linking such a reserve book with a displayed market.